Being self-employed can come with its challenges, and so it probably doesn’t come as a surprise that it’s especially true when it comes to getting a home loan approval.
As a small business operator, you may feel you have to jump through some extra hoops in order to prove your income level and financial stability compared to someone that is a PAYG employee.
Don’t let this discourage you — depending on your unique situation, it’s still possible for you to get a home loan approval, and it’s not always much more difficult than someone that is an employee!
As a self-employed operator, we will look at what kind of evidence you may need to prove you can meet the repayments for the proposed loan.
We will also look at some of the other considerations you may need to be aware of as far as lender’s criteria are to get a home loan approved.
Some things that lenders use to assess your ability to service the loan, i.e., are you able to repay the debt, are the same regardless of whether you are a self-employed applicant or work for someone and earn wages?
Before we get to these things, let’s look at what most lenders will want to see as proof of your self-employed income, which they will use to determine your ability to repay the debt.
First up, lenders will want to see that your business has been trading profitably over at least the last two financial years.
This documentation applies to what we term as a full documentation loan as opposed to an alt doc loan, sometimes referred to as low doc, which we will discuss briefly below and in another blog.
What documentation will you need to Provide Proof of income?
You may think that someone that works for a business earning regular wages has it easier than you who is a self-employed business owner, as they may only have to show their two most recent pay slips to prove their income, they don’t even have to be in their current job for two years, some lenders will even consider one day employment for a home loan approval.
Back to being a self-employed business owner, you usually will need to provide two years of trading history and depending on the business structure you operate your business as, for example do you operate your business as a sole trader, company, or a trust.
Getting a loan approved when you operate as a Company
For example, if you operate your business as a company, you will usually need to show two years’ profitable trading history in the form of two years company tax returns and two years accountant prepared financials, sometimes known as a profit-and-loss statement and balance sheet.
You will also need to provide two years’ personal tax returns.
Are there any exceptions to the two years self-employed documentation?
Yes, sometimes there are exceptions to this, as some lenders will consider a loan application using one-year financials, but usually the LVR needs to be 80% or less, and you will have to have been trading for either 18 months to two years as well.
The summary below is the usual forms of documentation that you will require depending on your business structure you use.
- If you’re a sole trader, you will need to provide two years of individual tax returns and the notice of assessment from the ATO.
- If you’re trading as a company, you will need to provide two years company and personal tax returns, full two years accountant prepare financial statements, you may also have to supply a notice of assessment from the ATO.
- Trading via a trust, documents required are similar to a company, two years trust tax returns and two years Trust accountant prepared financial statements, along with two years personal tax returns, you may also have to supply a copy of your trust deeds as well.
As mentioned, Lenders will want to see that your business is trading profitably, especially if your income varies from year to year.
For example, if your business income has increased by over 20% in the latest financial year compared to the previous year than you may find that lenders may use the previous year’s income and multiply this by 120% which they will use as a figure for income verification.
This means that even if the latest figures are much higher, this still may not improve your borrowing capacity. This is only one example. There are many, which is why it’s best to speak with a professional.
What if you cannot show two years’ financials?
If you cannot verify your self-employed income using the traditional methods, you may still get an approval using a Low doc or Alt Doc lending product.
This may be an option to consider. Briefly, alt doc lending is where you verify your capacity to repay the debt using alternative documentation to get an approval.
For example, some lenders will have an alt doc loan product. You might be able to demonstrate your ability to repay the debt using the latest two BAS periods and 6 months’ business bank statements, for example.
On the other hand, some lenders will want to see a whole 12 months’ worth of BAS and 12 months’ worth of business bank statements.
If you are looking at using an alternative documentation, it might be best to speak with a professional as the type of documents can vary between different lenders.
Build Your Credit Score
Another way to show that you’re financially stable (and thus more likely to receive approval) is by having a good credit score. Make sure you pay your bills on time, every time.
If possible, keep your credit card limits and balances low, regardless of the balance lenders will assess your ability to pay a loan based on the credit limit, not the current balance.
Avoid getting additional debt and unnecessary credit enquiries. These are all great ways to build and maintain your credit score. It won’t happen overnight, but given time, it will improve.
In most cases, a credit score above 600 will be required for most prime lenders to consider giving you a loan; anything above 700 makes the process even easier since it shows that you manage debt and making payments on time consistently.
DTI – debt to income ratio
Depending on whether you are looking to purchase a property to live in, i.e. as owner occupied or as an investment lenders will want to see that your Debt to income ratio is within an acceptable level, usually if your DTI is over 7.5 then you might find that the lender will decline your application even if you have a net surplus amount after loan repayments per month.
Regardless of your income, you also need to have a debt-to-income ratio of less than 6 to 7.5 depending which lender is being used.
What is DTI? It’s a financial measure that compares your monthly debt payments to your monthly gross income.
It’s often used by lenders to work out an individual’s ability to repay their debts.
A high DTI can have your application declined as it may be outside lender policy.
Speak with a Professional Mortgage Broker
Rather than trying to do it yourself, it might make sense to speak with a professional mortgage broker who will be able to guide you as to the best options available to you based on your unique circumstances.
By doing so, you will avoid extra hits on your credit file as a professional mortgage broker will be able to determine who you would most likely receive an approval from.
In other words, who you would fit with, i.e., what lender is most likely going to approve your application before making anything official.
Trying to do it yourself may not be the best idea, especially when it comes to the paperwork involved which can seem overwhelming.
Getting a home loan when your self-employed takes some extra effort but isn’t impossible! By providing accurate proof of income, maintaining good credit habits, and seeking professional help, anyone who works for themselves should be able to feel confident in their ability to apply for and receive a home loan approval.
With the right knowledge and preparation, anyone can get a loan approved and become a homeowner regardless of their employment status!
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